A small Chinese startup stood up to patent bullying from the maker of Siri – and won

Shanghai's CooTek, maker of a smartphone keyboard called TouchPal, expected to be sued by Nuance Communications. After all, the Burlington, Massachusetts-based software company, best known for owning the voice-recognition technology behind Apple’s Siri, has a history of aggressive patent litigation. Over the past 12 years, it has sued at least 10 companies over alleged patent infringements. It went on to acquire some of those companies, including Zi and Vlingo, after the cases were settled.

But CooTek, which, according to CEO Michael Wong, had recently turned down an acquisition offer from Nuance, did not anticipate being hit with three simultaneous law suits in three different courts. In December 2012, the 100-person startup found itself facing patent infringement suits not only in a US district court and a court in Shanghai, but also in a United States International Trade Commission (ITC) court, a high-stakes procedure that typically costs a defendant between $5 million and $10 million. Nuance was bringing a nuclear weapon to a knife fight.

What transpired over the next 10 months, however, is a David-and-Goliath case of startup defiance in a system that overwhelmingly favors giants. In the face of a financial mismatch, CooTek stared down Nuance in one of the most expensive courts in the world. In doing so, it hit back against a company that has a track record of using litigation to bully its opponents and acquisition targets into submission, while scaring off potential future competitors in the process.

For a lot of Chinese companies, let alone startups, an ITC case is simply unaffordable. “Many companies in the past when faced with a patent litigation in the US or ITC litigation would have abandoned the market in the US, because they just can’t afford to litigate,” says Douglas Clark, a Hong Kong-based intellectual property lawyer.

Indeed, CooTek felt overwhelmed by the prospect of the expensive showdown. Nuance had charged that CooTek infringed on five patents, covering a combination of tap-based and swipe-based keyboards. “We thought this is definitely bad news for a smaller company,” says Wong, a former Microsoft product manager who formed the startup with his two co-founders in 2008.

CooTek's TouchPal keyboard.

CooTek had been doing well. TouchPal was the first smartphone keyboard in the world to offer gesture-based inputs whose predictive powers extended entire sentences, not just words. The Android-based keyboard had reached more than 100 million users, and CooTek licensed it to major handset manufacturers, including HTC, Huawei, and ZTE. In 2009, it won a GSMA Mobile Innovation Award. The same year, it won a $100,000 prize in a Qualcomm wireless business competition. In 2011, it was one of six finalists at TechCrunch Disrupt Beijing’s Startup Battlefield. It had received funding from Qiming Ventures, and it was counting annual revenue in the millions of dollars. (Wong declined to disclose either amount.)

All of that, however, was threatened by the prospect of a costly ITC suit. CooTek was confident its technology did not infringe on Nuance’s patents, but it was not so sure that it could afford the court battle. Even if CooTek prevailed, Nuance would not be obliged to help the smaller company pay its legal fees. On the other hand, a $10 million lawsuit would be a minor expense for Nuance, a public company of 6,000 people with annual revenue of close to $2 billion and a market capitalization of more than $4 billion.

Ultimately, Wong decided to take a stand on principle. “Our dream as a startup is to build up something that’s very useful and bring value to end users,” Wong recalls telling CooTek’s investors. “We have a dream and we should protect it – even if we have to use most of our cash to fight back.”

Fight back it did. CooTek hired attorneys from Finnegan, Henderson, Farabow, Garrett & Dunner, one of the top intellectual property firms in the US. To keep its costs down, CooTek asked that Finnegan assign only a small team to the case. It used its own engineers and a China-based law firm to help with document discovery.

Over the course of the ensuing 10 months, the ITC judge hollowed out Nuance’s case to the point where the two parties felt it advantageous to settle. CooTek would be allowed to continue distributing TouchPal in the US, and Nuance promised not to sue CooTek’s clients. Lawyer Douglas Clark says the outcome is favorable to CooTek because it could continue to sell its products in the US. “They must be considered the winner,” Clark says.

As part of the settlement CooTek agreed to pay Nuance a fee, which Mike Thompson, executive vice president and general manager for Nuance Mobile, told PandoDaily is payment for technology IP that CooTek violated. CooTek’s Wong, however, characterizes it as an “insurance fee that we paid for our customers.” It saved the company time and money by wrapping up the case faster than it would otherwise have been, he says.

In an email response to written questions from PandoDaily, Finnegan attorney Qingyu Yin backed up Wong’s assertion and said that while the amount is confidential, “we believe the amount of payment is far below what is required for ‘recognition’ of a patent.”

Nuance’s Thompson says he doesn’t see the settlement as a loss for his company. It went after CooTek, he says, because it believed the company had copied Nuance's technology. “They were very clearly violating our intellectual property around keyboards,” says Thompson.

He also insists the suit had “absolutely nothing to do with an acquisition or anything related to that.” It was merely a recognition that mobile is a very competitive marketplace for intellectual property, “and it’s been Nuance’s position to enforce our intellectual property consistently.”

Wong defends CooTek against claims of copying by pointing out that his company won innovation prizes for TouchPal. He also notes that the publicly available agreement resulting from the case says that both parties shall not construe the settlement as an admission of any liability or wrongdoing.

History of aggression

Nuance is well known in technology circles for its combative approach to intellectual property. A 2011 Businessweek story by Peter Burrows noted that CEO Paul Ricci has acquired more than 40 companies since joining Nuance in 2000, an empire-building effort that has in many cases involved much IP arm-twisting. Its patent litigation history includes suits against mobile software developer Zi, automated telephone-response system Tellme Networks, intelligent assistant software maker Vlingo, and, most recently, ABBYY.

After weakening them with costly litigation, Nuance ended up acquiring Zi and Vlingo, and it tried to do the same for Tellme, which used speech software owned by another company that Nuance had bought. Tellme’s CEO at the time was Mike McCue, who went on to found Flipboard. McCue told Businessweek’s Burrows that Ricci had contacted him to say he would sue Tellme, introduce a competing product, and refuse to sell it more software unless Tellme agreed to Nuance's acquisition terms. McCue later sold Tellme to Microsoft for a much higher price, reported to be $800 million, after a court dismissed Nuance’s patent claims.

For Vlingo, it was worse. At one time, the Boston-based startup was involved in seven patent suits with Nuance. Then-CEO Dave Grannan compared competing with Nuance to “having a venereal disease that’s in remission.”

"We crush them whenever we go head-to-head with them,” Grannan told Businessweek. “But just when you're thinking life is great – boom, there's a sore on your lip.”

Not long after that article was published, the two companies put aside their differences, and Nuance acquired Vlingo for a price that the latter found satisfactory – believed to be somewhere in the order of $200 million. But the battle wasn’t without its drama. In proceedings filed in a Massachusetts district court, Vlingo charged that Nuance conducted its negotiations in bad faith. It also accused Nuance of bribery. (The case was dismissed when Nuance completed the acquisition of Vlingo.)

In February 2007, the document notes, Nuance’s head of corporate development, Richard Palmer, told one of Vlingo’s founders, Michael Phillips, that CEO Ricci was disappointed that Vlingo would not accept an offer to be acquired.

“Mr. Palmer informed Mr. Phillips that Mr. Ricci can be vindictive if he does not get his way and that Vlingo would not be happy if Mr. Palmer and Mr. Phillips could not work out a technology partnership,” the filing notes.

To put a cherry on top, Palmer threatened to saddle Vlingo with exorbitant legal costs. “[Palmer] told Mr. Phillips to inform his Board that they can either take the technology partnership deal offered by Nuance or pay $20 million in legal fees vindicating themselves in intellectual property litigation.”

In the court documents, Vlingo also alleges that Ricci offered to pay the three Vlingo founders $5 million each if they could convince their board of directors to approve the acquisition on Ricci’s terms. Ricci also offered the founders an alternative: “$5 million each plus the monies they would have received had the acquisition went through, if they would quit Vlingo and work for Nuance.”

The Vlingo executives rejected the offers.

Not a troll, but a bully

Vlingo weathered the storm of the lawsuits, and Nuance eventually paid much more for the company than it was originally willing to. Former CEO Grannan, who has left Vlingo and is now an advisor to Syntellia, maker of the Flesky keyboard, says that Vlingo probably would have taken its chances of becoming an even bigger company had it not been for the patent lawsuits constantly hanging over its head.

Grannan says that Nuance’s legal tactics are a key part of its business strategy.

He says: “The general theme of Nuance is that they exploit a very broken patent system in the US as a business tool to typically cause harm to small companies that they generally want to acquire or put out of business.”

The US patent litigation system effectively assumes that alleged infringers are guilty, Grannan says. Even if the defendants win the cases, they get nothing – not even compensation for legal fees.

An artist's rendition of a patent troll.

That, however, may be about to change. On Thursday, the US House of Representatives is expected to vote on the Innovation Act, which would implement a “loser pays” system. Such a system may dissuade frivolous patent suits, and it would raise the stakes for companies like Nuance in suits like the ones it brought against Vlingo and CooTek. The Innovation Act's main targets are "patent trolls," patent-owning entities that sue companies based on vaguely defined patents despite not owning or using associated technology.

Grannan compares Nuance’s behavior towards startups to the behavior of these trolls. “It’s just intellectual property blackmail,” Grannan says. “It is designed to inflict the maximum amount of harm, not to reach an intellectual property settlement.”

“I’m unaware of any other technology based company that uses its patent portfolio as an offensive weapon to crush and put startups out of business,” he adds. “Nuance clearly has a very intentional strategy of stifling young companies before they become a threat, or buying them on the cheap.”

Julie Samuels, a senior staff attorney at the Electronic Frontier Foundation and the Mark Cuban Chair to Eliminate Stupid Patents, says that while Nuance is acting within the law, its behavior hurts the “innovation economy.” Unlike a troll, Nuance owns products related to its patents, Samuels says, “but just because a company has products or services, that doesn’t mean it’s not behaving foolishly.”

She says the majority of startups would not be able to come up with the millions of dollars required to defend a patent suit such as the one faced by CooTek. “Frankly it’s not do-able at all,” she says. “That prospect is insane.” She wishes companies would compete in the marketplace and not in the courts.

For CooTek, the fight might not be over. For now, it is in the clear, but comments to PandoDaily by Nuance’s Mike Thompson suggest there might be more to come. Although he would not be drawn on the question of whether or not Nuance plans to take further action against CooTek, Thompson did note that it filed its suits against the Chinese company based on only a few of the hundreds of patents that might have been applicable. It might be the case that CooTek has unwittingly stepped “out of the frying pan and into the fire,” Thompson says.

It’s possible to view this case, which on the face of it seems like a set back for Nuance, as no great loss to the communications giant. If aggressive litigation is part of its business strategy, then a settlement, or even a judge’s ruling, might be secondary to the wider goal of sending a message to potential competitors that they cannot expect to enter the space and escape a lawsuit. In this case, the appearance of menace can be as effective for Nuance as actually winning its suits, on which front it has proven woefully lacking. The expense of the litigation can just be written off as a cost of doing business.

CooTek’s Wong, meanwhile, wants to move on. “We don’t really want to argue with [Nuance], because they are a public company. They really care about their public image. For us, the most important thing is business, the innovation, and to survive and keep the possibility to provide the best products to our clients.”

Wong considers CooTek’s defense against Nuance “a big victory.” And he’s prepared to go another round. When asked if he is worried about the prospect of Nuance taking CooTek back to court, Wong says, “If Nuance sues again, we will defend ourselves, like we did in this case, only more forcefully.”

This time, a startup prevailed over its assailant. For the implications of the victory to extend beyond just the two companies, however, the focus needs to shift from litigation to legislation. The next important battle in the fight to improve the US's faltering patent system will be fought not in the courtroom, but in Congress.

CooTek's heroics have exposed the holes in the system. Now someone needs to patch them up.